Steady sales growth holds the key to survival in an ever changing and highly competitive business environment. But when it comes to picking stocks, investors often ignore sales growth as a reliable metric. This might be because of their preconceived notion that a company’s stock price is typically sensitive to its earnings momentum.
Nevertheless, it’s worth keeping in mind that when companies incur losses, albeit temporarily, they are valued based on their revenues, as top-line growth (or decline) is usually an indicator of a company’s future earnings performance.
Further, a company can improve earnings by resorting to expense control measures while maintaining stable revenues. However, sustainable bottom-line growth invariably requires higher revenues.
Hence, the Price-to-Sales (P/S) ratio can be an apt metric for stock valuation. The importance of this metric lies in the fact that management has limited scope to manipulate revenues unlike earnings.
While sales growth provides investors an understanding of product demand and pricing power, it doesn’t reflect whether the company is operating efficiently. A huge sales number does not necessarily convert into profits.
So, a consideration of a company’s cash position along with its sales can be a more dependable strategy. Significant cash in hand and steady cash flow give a company more flexibility with respect to business decisions and investments.